PwC outlines four potential Eurozone outcomes for 2012

Monetary expansion through a liquidity injection from the European Central Bank, orderly defaults for the most indebted countries, Greek exit and a new currency bloc have been outlined as four potential outcomes of the Eurozone crisis in 2012, in a PwC report launched on 5 December 2011, “What next for the Eurozone – Possible scenarios for 2012”. The report analyses each of these scenarios and outlines the outcomes of each in terms of the potential Eurozone inflation and GDP impact from 2012 until 2016.

Four potential scenarios summary:

Scenario 1 – Monetary expansion

The European Central Bank is given the go ahead to inject significant liquidity to vulnerable economies. Recession is avoided, interest rates are kept low in the short term, but inflation rises well above its 2% target, while the euro depreciates.

Scenario 2 – Orderly defaults

A programme of voluntary defaults is agreed for the most indebted countries, which triggers a contractionary debt spiral and a prolonged recession, lasting between two and three years, and which results in a cumulative loss in GDP of around 5% in Eurozone.

Scenario 3 – Greek exit

Greece is compelled to leave the Eurozone, and then suffers a sharp deterioration in its economy, a rapid depreciation of its new currency and an inflation spike. The Eurozone seeks to protect its currency through tough fiscal discipline and other investor confidence increasing measures, but still suffers a recession that lasts up to two years.

Scenario 4 – New currency bloc

A Franco-German acknowledgement that the existing Eurozone is unsustainable paves the way for a new, smaller and more tightly regulated currency bloc. The ‘new-euro’ would be expected to appreciate dramatically and for the new bloc to benefit from a boom in domestic demand. Economies that are excluded suffer a sharp currency depreciation and severe economic contraction. “Beside clear impact of Scenario 2, the Czech Republic would also be negatively impacted by Scenario 4. As subcontractors of Germany we would, of course, not welcome „deuro“, which would significantly appreciate and it would lead to decrease of exports of new „deurozone“. Domestic firms would, however, be given the opportunity to replace the German companies on foreign markets (at least partially) which could be (with a little optimism) possible during several years but in short term, they are not prepared yet,” says Zdeněk Hrdlička, Analyst, PwC Czech Republic.